How low can stocks go? Updated risks and values – June 2nd


How low can stocks go? Updated risks and values – June 2nd

Bottom Line: The purpose of this story is to inform you as to what's possible in a near worst-case outcome for the financial markets. The reason is to understand what's possible, though unlikely, so you can plan soundly for your financial future unemotionally. The US stock market is the greatest wealth creation machine in the history of the world. I want you to benefit from it without making emotional mistakes with money.                  

Too often when we have a rare short-term downturn in the markets - it's too late to offer up information that might have been helpful ahead of time. This week's edition of "how low can stocks go" goes as follows...re the Dow, S&P 500 & Nasdaq stand against their all-time high levels:                           

  • DOW: 14% off record high
  • S&P 500: 10% off record high
  • Nasdaq: 3% off record high

Markets were higher across the board over the past week as stocks continue to perform far better than the real economy and the overall mood of the country for that matter. Investors are increasingly betting on a fairly quick rebound with the economy reopening but there are far more questions than answers about what a recovery will look like. In part due to uncertainty about the threat of the virus from here, along with timing for treatments and a vaccine, but even more so due to 40 million people currently unemployed. This week’s jobs report will be especially important for understanding what happened in the labor market with furloughed employees as businesses reopened.If there’s evidence we hit the bottom in May, the increased optimism might be justified – if not...

The other major factor keeping stocks buoyant is the fed. The fed’s backstopping of $6 trillion in the economy, much of which has found its way to stocks is reminiscent of the QE coming out of the Great Recession. For this reason, it’s possible, even likely stocks will continue to perform better than the real economy. The final ingredient is money on the sidelines. An estimated $4 trillion in investor money is in money market accounts looking for a place to go. As these investors become more comfortable with stocks, more of that money will find them.

Here’s where the markets stand year to date.

  • The Dow is down 11%, the S&P 500 down 5% & the Nasdaq is up 6%

If only market fundamentals mattered here's what we'd want to consider regarding the S&P 500 for example.                           

  • S&P 500 P\E: 21.91
  • S&P 500 avg. P\E: 15.79

The downside risk is 28% based on earnings multiples right now from current levels. That's 7% less risk compared with this time last year, however fundamentals on trailing earnings will deteriorate. The market is priced as though earnings will only drop by about 7% this year. That might be a bit too optimistic. I’d be prepared for worse, just in case.

It's always important to ensure that you're positioned for negative adversity. If another 28% decline wouldn't affect your day-to-day life, you're likely well positioned. If not, you should probably seek professional assistance in crafting your plan that balances your short-term needs with long term objectives.

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